Green Bookkeeping

‘Green’ Bookkeeping Shows Real Business Costs. In 2010, Puma pioneered a new form of corporate reporting. The German sportswear company produced an environmental profit and loss account, which estimated the company and its supply chain to have caused €145m of environmental damage that year, relative to €202m of net profit.

In other words, if Puma expensed the costs to the environment of its activities and those of its suppliers, earnings would fall by more than two-thirds.

Conventional bookkeeping allows companies to ignore such damage. The activities of Puma’s supply chain involve a number of environmental and social costs, such as the chemical pollution of waterways via the dumping of untreated wastewater.

But because these costs are imposed on outside parties, and therefore fall outside the scope of suppliers’ P&Ls, there is no obligation to quantify or expense them. Instead, they go unrecorded and are borne by the rest of us.

This is what economists call market failure. Companies are not forced to pay their full costs, leading to socially inefficient outcomes – and the results are all too apparent. In China, the global centre for textile production, the government acknowledges that nearly half of the rivers are so contaminated with hazardous chemicals as to be unsuitable for human contact; Greenpeace, the environmental group, estimates the proportion is much higher.

Evidence suggests that Puma and its supply chain are not unusual. The activities of the largest 3,000 public companies globally are estimated to cause environmental damage equal to 50 per cent of combined earnings.

The same fundamental issue is triggering a parallel debate at a macroeconomic level. Chinese gross domestic product includes the output of the factories polluting its rivers, the necessary clean-up projects and the medical expenses of the villagers poisoned by lead, mercury and arsenic. It ignores the associated loss of life, livelihoods and ecological vitality.

The patent absurdity of using this as a guide to public policy has led to the formation of a number of alternative, broader conceptions of progress. Such ideas are slowly seeping into public discourse and policy formation around the world.

Chinese agencies, for instance, attempted to calculate a “green GDP”. Despite the results ultimately being blocked by the government, the idea survives. Pilot emissions trading schemes are in place, 74 cities have been forced to publish real time air quality data and companies in polluting industries made to procure “compulsory insurance” to ensure they can provide compensation to victims of the damage they inflict.

In China and elsewhere, political and regulatory threats to “business as usual” are rising. Privatisation of profits and socialisation of costs is increasingly unacceptable to the public and the principle of the polluter pays has gained widespread policy acceptance, in theory if not yet in practice.

The consequence is that the ability of the private sector to externalise costs is waning. Companies in numerous jurisdictions are already forced to pay for the most obvious aspects of their environmental damage through carbon taxes and cap and trade schemes, as well as emissions charges. To combat the threat they pose to public health, tobacco and alcohol producers and retailers are being regulated more onerously. In future, such state intervention is likely to broaden in scope and deepen in nature, be it to expand emissions schemes to more sectors and pollutants, or to target excessive fat, salt and sugar content through taxes or caps.

These threats present clear business risks to a very wide range of companies and industries. Executives and investors need to consider these as core business and investment issues.

Corporates ought to act pre-emptively to mitigate these risks by managing and reducing external costs wherever possible, and long-term investors ought to encourage and demand they do so. Not doing so means running the risk of losing long-term social licenses to operate.

Quantifying external costs is a powerful step in this direction. Puma’s 2010 environmental P&L is the first step of three that will attempt to incorporate the environmental, social and economic impacts of the company and its supply chain. The final version should represent a pioneering set of full cost accounts that allow managers to identify risks, audit the supply chain and take remedial action.

Putting a monetary value on external costs is particularly useful, since this allows companies to incorporate thinking about how to alleviate them directly into existing financial and operational systems.

Momentum is gathering behind such initiatives. Next year, a dozen companies are reported to be joining Puma in publishing EP&Ls and creating an industry coalition to push for broader adoption.

More widespread calculation and disclosure of environmental and social impacts – even at the margin and far short of Puma’s ambitious effort – should be welcomed and encouraged by long-term investors attempting to identify franchises that are well positioned for coming challenges.

Jack Nelson

First published in the Financial Times on Monday 24 June 2013

Important information

This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment recommendation or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document.

This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the information. We do not accept any liability for any loss arising whether directly or indirectly from any use of this document.

References to “we” or “us” are references to Stewart Investors. Stewart Investors is a trading name of First Sentier Investors (UK) Funds Limited, First Sentier Investors International IM Limited and First Sentier Investors (Ireland) Limited. First Sentier Investors entities referred to in this document are part of First Sentier Investors, a member of MUFG, a global financial group. First Sentier Investors includes a number of entities in different jurisdictions. MUFG and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk including loss of income and capital invested.

Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell. Reference to the names of any company is merely to explain the investment strategy and should not be construed as investment advice or a recommendation to invest in any of those companies.

Hong Kong and Singapore

In Hong Kong, this document is issued by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. In Singapore, this document is issued by First Sentier Investors (Singapore) whose company registration number is 196900420D. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. Stewart Investors is a business name of First Sentier Investors (Hong Kong) Limited. Stewart Investors (registration number 53310114W) is a business division of First Sentier Investors (Singapore).

Australia

In Australia, this document is issued by First Sentier Investors (Australia) IM Limited AFSL 289017 ABN 89 114 194 311 (FSI AIM). Stewart Investors is a trading name of FSI AIM.

United Kingdom

This document is not a financial promotion. In the United Kingdom, this document is issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registration number 143359). Registered office: Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB, number 2294743.

European Economic Area (“EEA”)

In the EEA, this document is issued by First Sentier Investors (Ireland) Limited which is authorised and regulated in Ireland by the Central Bank of Ireland (registered number C182306) in connection with the activity of receiving and transmitting orders. Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland, number 629188.

Middle East

In certain jurisdictions the distribution of this material may be restricted. The recipient is required to inform themselves about any such restrictions and observe them. By having requested this document and by not deleting this email and attachment, you warrant and represent that you qualify under any applicable financial promotion rules that may be applicable to you to receive and consider this document, failing which you should return and delete this e-mail and all attachments pertaining thereto. In the Middle East, this material is communicated by First Sentier Investors (Singapore).

Kuwait

If in doubt, you are recommended to consult a party licensed by the Capital Markets Authority (“CMA”) pursuant to Law No. 7/2010 and the Executive Regulations to give you the appropriate advice. Neither this document nor any of the information contained herein is intended to and shall not lead to the conclusion of any contract whatsoever within Kuwait.

UAE - Dubai International Financial Centre (DIFC)

Within the DIFC this material is directed solely at Professional Clients as defined by the DFSA’s COB Rulebook.

UAE (ex-DIFC)

By having requested this document and / or by not deleting this email and attachment, you warrant and represent that you qualify under the exemptions contained in Article 2 of the Emirates Securities and Commodities Authority Board Resolution No 37 of 2012, as amended by decision No 13 of 2012 (the “Mutual Fund Regulations”). By receiving this material you acknowledge and confirm that you fall within one or more of the exemptions contained in Article 2 of the Mutual Fund Regulations.

United States of America

In the United States, this document is issued by First Sentier Investors International IM Limited, as SEC registered investment adviser. Stewart Investors is the trading name of First Sentier Investors International IM Limited. This material is solely for the attention of institutional, professional, qualified or sophisticated investors and distributors who qualify as qualified purchasers under the Investment Company Act of 1940 (hereafter the “1940 Act”), as accredited investors under Rule 501 of SEC Regulation D under the US Securities Act of 1933 (“1933 Act), and as qualified eligible persons as defined under CFTC Regulation 4.7. It is not to be distributed to the general public, private customers or retail investors.

Other jurisdictions

In other jurisdictions where this document may lawfully be issued, this document is issued by First Sentier Investors International IM Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registration number 122512). Registered office 23 St. Andrew Square, Edinburgh, EH2 1BB number SC079063.